Octave Specialty Group Inc (OSG) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Overseas Shipholding Group third-quarter 2015 earnings conference call. (Operator Instructions)

Please do note today's program is being recorded. I would like to now introduce James Small, General Counsel, for our opening remarks.

Thank you. Good morning, everyone, and welcome to the third quarter of 2015 earnings release conference call. Before we begin, I would like to start off by advising everyone on the call with us today of the following.

During this conference call, management may make forward-looking statements regarding OSG or the industry in which it operates which could include without limitation statements about outlook for tanker and articulated tug barge markets, changing oil trading patterns, forecasts of world and regional economic activity and demand for and production of oil and petroleum products, OSG's strategy, expectations regarding revenues and expenses, including G&A expenses and vessel expenses, estimated TCE rates achieved for the third quarter of 2015 and booked for the fourth quarter of 2015, estimated capital expenditures for 2015 or other periods, projected scheduled drydocks or off hire days, OSG's ability to achieve its financing objectives, and regulatory developments in the United States and elsewhere.

Any such forward-looking statements take into account various assumptions made by management based on its experience and perception of historical trends, current conditions, expected and future developments, and other factors management believe are appropriate to consider in the circumstances.

Forward-looking statements are subject to a number of risks, uncertainties, and assumptions, many of which are beyond the control of OSG, which may cause actual results to differ materially from those implied or expressed by the forward-looking statements. Factors, risks and uncertainties that could cause the actual results to differ from expectations include those described in OSG's annual report on Form 10K for 2014 and in other filings that OSG has made or in the future may make with the US Securities and Exchange Commission.

With that out of the way, I would like to turn the call over to our President and Chief Executive Officer, Captain Ian Blackley. Ian?

Thanks, James. So, good morning, everyone, and thank you for joining us for our 2015 third-quarter earnings call. On the call with me today in New York are Rick Oricchio, our CFO, Lois Zabrocky, Head of our International Business, James Small, our General Counsel, and Brian Tanner, Head of our Investor Relations. Joining us from Tampa, Florida is Henry Flinter, Head of our Domestic Business.

Before reviewing our third-quarter results, I want to highlight some steps we have taken this quarter to enhance our capital structure, positioning the firm to take advantage of growth opportunities and deliver value to our shareholders.

During the quarter, we purchased $101 million of our bonds in the open market. Also our Board has authorized a $200 million equity repurchase plan for purchases during the next two years. We are very positive about the Company's prospects and believe that the level that our Class A shares have been trading recently in private transactions does not reflect the Company's true value. This buyback plan allows us to build value for shareholders by investing in the Company when we see attractive pricing.

Establishing a trading market for our A shares is a priority of the Company. We remain in registration and will continue to evaluate market volatility.

Turning now to our third-quarter results and an update on each of our segments, I am pleased to report another set of strong results today with adjusted EBITDA in the quarter of $124 million on TCE revenues of $234 million. Our net income was $173 million, which included tax benefits of $119 million that Rick will discuss in more detail. Income before the tax benefit was $54 million with both of our businesses contributing to this strong performance.

In the international crude sector, the outlook remains positive as we enter what historically is the strongest part of the year. Global oil production remains at record levels as lower US production has been more than offset by record production levels from OPEC countries, driven primarily by Saudi Arabia and Iraq.

This global oversupply sustains lower oil pricing which acts as a stimulus to refinery and end-user demand. It's also providing motivation for China to continue stockpiling crude for its strategic petroleum (inaudible).

In addition to this oil demand growth, the international tanker market continued to benefit from increased ton mile demand. Against this, we have seen a growing [evolving] order book and fuel deletions due to the strength of the freight markets. As a result, net fleet growth is projected to rise. However, we believe this supply-side growth is manageable, given the positive outlook for ton mile demand.

These strong fundamentals led to significantly improved Q3 rates in our crude sectors in what is typically a seasonally weaker period. Third-quarter average VLCC spot rates increased to $57,600 per day, up nearly 3 times from same period in 2014. Aframax spot rates increased to $35,500 per day in the quarter, up 80%, and the Panamax blended rate increased to $19,000 per day, up 19%.

The international product sector fundamentals also remained strong. Lower crude oil prices and strong demand for petroleum products, both in the US and globally, have led to favorable margins that encourage high refinery utilization. TCEs for the larger product vessels strengthened during the quarter as a number of refineries in the Middle East and India increased throughput, stimulating long-haul product tanker demand.

With somewhat limited fleet growth compared with recent years, the supply/demand fundamentals led to significantly improved rates on MRs. This is evidenced by a third-quarter MR spot rate, nearly doubling to approximately $22,000 per day, up from $11,800 per day in the same period of 2014.

In the Jones Act, market sentiment has softened on declining domestic crude production and expected future declines through the middle of 2016. In addition, there are a significant number of new builds entering the market over the next two years. We expect to find a more challenging employment environment for our older ATBs that come off existing time charters in 2016. We believe our ATB and tanker customers will tend to take a wait and see approach, hoping for greater clarity in the direction of global crude oil pricing and the resulting direction of domestic crude oil production.

While there has been a decline in spot charter rates in the Jones Act sector during the quarter, we signed a new three-year time charter on a Jones Act tanker at a higher rate than expiry. And as of today, 81% of our revenue days for 2016 are fixed on time charter or Seaway business. And we are also seeing a significant pickup in Delaware lightering volumes due to the increased crude oil imports.

Our third-quarter results reflect the earning power of our 79 vessel fleet and the effectiveness of our operating strategy. Our international fleet predominantly trades in the spot market, which continues to demonstrate underlying strength in both crude and product, and we enjoy the security of medium-term time charters in the domestic market. Our strong cash generation is giving us significant flexibility to enhance our capital structure, position the firm to take advantage of growth opportunities, and deliver value for our shareholders.

I will now turn the call over to Rick to provide additional details on our third-quarter results. Rick?

Thanks, Ian. Let's move directly to reviewing the third-quarter results in more detail.

TCE revenues grew to $234 million for the quarter, an increase of $57 million or 33% compared with the third quarter of 2014. This increase was principally driven by continuing strength in crude and product spot market rates. TCE revenues grew to $690 million for the first nine months of 2015, an increase of $128 million or 23% compared with the first nine months of 2014.

Adjusted EBITDA was $124 million for the third quarter, an increase of $58 million compared with the third quarter of 2014. Again, driven primarily by the strength of spot rates in the international crude and product markets.

Included in adjusted EBITDA in the quarter are a number of nonrecurring items. A $2 million cost recorded due to the repurchase of our bonds, a $3 million write off of IPO related costs, and $1 million of reorganization costs. These were partially offset by a $3 million gain we recognized on a 1998 built MR tanker that was sold during the quarter.

Adjusted EBITDA was $368 million for the first nine months of 2015, an increase of $161 million or 77% as compared with the first nine months of 2014. Net income for the third quarter and first nine months was $73 million and $275 million, respectively, compared with $11 million in the third quarter of 2014 and a net loss of $179 million for the first nine months of 2014.

Net income for the third quarter included a net tax benefit of $119 million, resulting from two unusual items we will discuss in a moment. Without that net tax benefit, net income would have been $54 million, an increase of $44 million compared to the third quarter in 2014.

I want to take a minute to discuss two unusual components of the tax benefit that we recorded. First, as previously disclosed, we had requested that the IRS, through its prefiling agreement program, review the deductibility of payments made by the Company during our emergence from bankruptcy in its capacity as a guarantor of certain OIN liabilities. During Q3, the IRS concluded its review and agreed that the payments are a deductible expense.

This provided us with approximately $425 million in net operating losses to apply against either prior or future taxable income and we therefore recognized an income tax benefit of $150 million.

These NOLs contributed to a $55 million cash refund claim, related to a tax loss carryback that we anticipate receiving in the fourth quarter, and increased our NOL carryforwards available to reduce future taxable income by approximately $390 million.

Second, accounting literature requires us to record a deferred tax liability on unremitted earnings of a foreign subsidiary unless we can assert that those earnings will remain indefinitely reinvested overseas. Up until our bankruptcy filing, the Company had asserted that the earnings of OIN would be indefinitely reinvested overseas. From emergence until now, the Company was not required to make this assertion as for accounting purposes, there were no undistributed earnings of OIN. Following the successful resolution of the IRS prefiling agreement, we had to assess whether we could continue to assert that the earnings of OIN would be indefinitely reinvested overseas.

We concluded that we could not assert that the OIN earnings would remain indefinitely reinvested overseas so we were required to recognize a deferred tax liability and tax provision of $31 million in the quarter. We currently believe that we will be required to record a non-cash deferred tax provision on OIN's income in subsequent periods.

However, we do not anticipate paying any cash tax on these earnings.

I would now like to discuss the results of our business segments beginning with the international crude tanker segment.

Third-quarter TCE revenues for the international crude tanker segment totaled $76 million, an increase of $27 million compared with the same period a year ago. The significant increase was driven by the continuing strength in the segment. Ian highlighted the strong performance in our third-quarter average spot rates and fourth-quarter performance continues to be strong. We have booked approximately 60% of the available VLCC spot days at an average of slightly over $60,000 per day and approximately 40% of the available Aframax spot days at an average of approximately $27,000 per day.

Approximately 40% of the available Panamax spot days have been fixed at an average of approximately $17,000 per day and improving.

TCE revenues were $220 million for the first nine months of 2015, an increase of $43 million compared with the first nine months of 2014. In the International Product Carrier segment, third-quarter TCE revenues totaled $50 million, an increase of $21 million compared with the second quarter of 2014 as MR rates strengthened. We have booked approximately 30% of our MR spot rates at an average of approximately $18,000 per day. TCE revenues were $136 million for the first nine months of 2015, an increase of $54 million compared with the first nine months of 2014.

In the US flagged segment, third-quarter TCE revenues totaled $107 million, an increase of $9 million from the same period a year ago, driven by a $6 million increase in Jones Act tanker TCE revenues.

TCE revenues were $334 million for the first nine months of 2015, an increase of $31 million compared with the first nine months of 2014, driven primarily by higher rates on both ATBs and tankers.

As Ian mentioned earlier, the sentiment for the Jones Act charter market has softened. If the factors giving rise to this sentiment continue, it could become increasingly difficult for our older ATBs to find employment at attractive rates that justifies our future investment in their next special survey and [ballast water treatment system. Based on these factors, management felt it was necessary to adjust the useful lives on six of our rebuild ATBs to end at their next special survey dates in 2019 and 2020.

This is expected to increase depreciation expense, beginning in Q4, by approximately $3.4 million per quarter.

Our third-quarter 2015 G&A totaled $21 million or $18 million, if we exclude the $3 million related to the writing off of the IPO costs compared with $19 million for the third quarter in 2014. This decrease was due to reduced employee-related costs.

From a liquidity standpoint, we ended the quarter with approximately $655 million of cash including $27 million of restricted cash, up from $512 million at the end of 2014. We also have access to undrawn revolving credit facilities of $125 million, bringing our total liquidity to $780 million.

With that, we will now open the call up to questions. Roland?

(Operator Instructions) [Fritz Lu], [Brodie] Capital.

A couple of things. First of all, regarding the bond buyback, could you actually tell us which of the two bonds you bought back?

Yes, we purchased about $62 million of the 2018 8 1/4s and $39 million of the 2021/2024s.

Okay, thank you. And then in terms of EBITDA, could you give us some color of the breakdown between the Jones Act and the international segment?

I don't have that. We don't have that. We don't -- we can get back to you on that.

Okay, thank you. And then, with regards to the six ATBs that you may scrap in 2019, 2020, could you also give us a breakdown of how much of the current EBITDA they contribute to the Jones Act or any color with regard to what that EBITDA may look like if you do scrap them in three-ish?

We don't break out EBITDA in that sector, Fritz, but the TCE's in the third quarter were 24% of the domestic TCE.

24%, okay.

And just to -- the next [special serve] in these units is not until 2019 and 2020.

Right. Okay, what percentage of the Jones Act fleet is coming up in 2016 and 2017 for contract renewal?

Henry, do you want to take that?

Sure. I can take that. About 20%.

In what? In 2016?

In 2016. So we have two tankers that are showing availability in the early April, May period. And then we have six ATBs that show availability in the mid- to late 2016 period. (multiple speakers)

And then '17?

I don't have that handy, sorry.

Okay, but rough (inaudible) mind roughly similar percentage of the fleet?

I --

I can follow up with you guys.

Yes, I don't have the numbers. So (multiple speakers) in 2016, the other two are in 2017 showing openings.

Okay, thank you very much. Thank you, guys.

Warren Kantor, Society Hill Capital.

Yes, I was wondering whether the write offs of the IPO cost is abandoned now or is that continuing?

That is not an abandonment. The accounting literature is pretty clear that if it is -- if it has gone cold for a period of 90 days, that the cost should be taken off the balance sheet, and we followed that guidance.

I see. Could you also tell me where you [are continuing to do your borrowing] of buyback program?

Your question is unclear. Can you repeat that, please?

Yes, have you continued to buy back bonds in the fourth quarter or do you have an intention to buy back more bonds with the cash flow as you did in the third quarter?

We will remain opportunistic as to whether or not we will be delevering the organization.

Okay, thank you.

(Operator Instructions) Kevin Van Dam, Credit Suisse.

Hi guys. Thanks for taking the question and congrats on a good quarter. I just wanted to ask you about the new charter you guys got in the Jones Act segment. If you could give any commentary around what rate you got there and what it was previously contracted for.

Yes, I'm sorry, Kevin, we don't -- we can't comment on specific charter rates.

Can you -- we are sort of hearing that the Jones Act is trading in the context of $70,000 to $75,000 today. Can you comment on whether it was in that context?

Well, it was somewhat shy of that.

Okay, fair enough. And the question around the stock buyback. Could you give a little bit of commentary around expectations of timing and how you are going to pursue that?

Rick.

I'm sorry, who is this, Kevin?

Yes. Kevin Van Dam for Credit Suisse.

This is Ricky O speaking. We remain very positive about our prospects and we believe that the level that we have seen -- the Class A trading act does not reflect the Company's true value. As a result, an equity buyback could represent an opportunity for us to build value for our shareholders, and we are going to monitor that situation. We have the Board's authorization to do it. The exact timing and manner in which we might work against that remain uncertain.

At this time, we have not made any purchases.

Got it. Thank you.

Erik Stavseth, Arctic Securities.

My question relates more to the development of the Company as you stand today because you have crude and then product in international and then you do have a certain fleet which now appears to be somewhat declining, given your comments on the ATBs within the Jones Act space. I just wondered could you give us some color on what you are thinking with a quite substantial portion of cash and then, also, which direction you are leading to in terms of the different markets.

So, we are -- our goal is to maximize value for our shareholders and we have looked at delevering in the third quarter and we continue to look at growth opportunities on both sides of the business; and as Rick has just mentioned, we now have the ability to invest in the Company through equity buybacks.

So, as we take these decisions, we will be happy to discuss them, but there's nothing specific we can get into in the moment.

All right. Second question to follow up on the question about the Jones Act vessel. Could you give us the name of the vessel that was renewed?

Henry, do you want to take that?

The vessel was the Texas City.

Texas City. Okay, thanks, that's all for me.

(Operator Instructions) Fritz Lu.

Hi guys, sorry. One more question regarding the cap structure. You are delevered now. You're also talking about share buybacks. Can you give us an idea what kind of leverage you are looking at given the uncertainty on the Jones Act and the historical volatility of the tanker market?

We like a leverage of approximately 50-50.

Okay. And in terms of EBITDA, do you have a goal for that as well?

No.

No, okay. Thank you.

Ryan Watson, Jefferies.

Could you tell me what the cash position is at the OSB level, the Jones Act level, and what the cash position is at the OIN level? And then, could you further -- could you remind me exactly what the dividend restrictions are from each level?

Ryan, this is Rick speaking. We don't break out our cash in our public documents by Company level. There are certain dividend constraints at the operating Company level, OBS and OIN, as to their ability to dividend cash up to the parent as outlined in the indentures. There are no limitation at the OSG level as to what it can do with its cash.

Just to clarify one thing Rick said. This is James Small. It's actually -- the restrictions on dividends are in the credit facilities, not in the indentures.

Right, okay. And so the monies that you are using to do the share repurchase strategically over the next few years, is that money that was already -- that was dividended up at one time from one of the operating companies to the hold co. and has been kind of sitting at hold co. or at the OSG level?

This is James. Just to be clear, the restrictions which we can follow up with you later on in the credit facilities do permit us to move some cash up from the subsidiaries to the parent. So -- and the buyback is over a two-year period. So it's -- I don't think we are in a position to tell you what cash we're going to use to do buybacks to the extent we determine to do buybacks which are in the best interest of the Company.

Thank you.

Jen Ganzi, NewMark Capital.

Hi guys, thanks for taking the question. Just wanted to follow up a little bit on the Jones Act situation. So I was just wondering with the potential for retiring I thought you said it was about 24% of your revenue or so, do you have anything to replace it? Do you have any sort of new ships in order? Maybe you can just refresh us on that.

Jen, we currently don't have new vessels in order in the Jones Act and just to be clear, these ATBs or special surveys are not until 2019 and/or 2020, and we do have the ability to trade them beyond that if we have customers who want them. We would look at the cost of the dry dock and the cost of the ballast water treatment at the time and then decide whether or not they would continue in service.

Okay. And then, to the extent that you -- I guess, sell those vessels, would those proceeds then come back to pay off the loans at the Jones Act subsidiary?

I didn't understand that question.

I'm sorry, Jen, can you repeat that please?

I said to the extent that you do sell some of these vessels that or whatnot would the proceeds from that sale then be used to pay down the loans that are at the Jones Act subsidiary?

Yes. But we have no current plans to sell these vessels. And I want to emphasize a point that Ian made, that these six ATBs -- their next special survey date is 2019 and 2020. We will evaluate at that moment in time whether it is appropriate to scrap them or not. A decision with respect to scrapping has not been taken at this moment.

Okay, got you. And you -- just another follow-up on the Jones Act. Do you have any of your -- what percent of your 2017 revenues are booked?

Henry, do you have that?

I don't have that number, no.

We will come back to you on that, Jen.

Okay. So I guess just to finish up, so I guess to the extent that you were going to potentially scrap those vessels, would you be thinking of investing in new vessels? I'm just kind of curious what the game plan for the Jones Act business would be if that decision was made in a couple years' time.

Including -- we don't have an answer for that question at the moment, Jen. Again, these -- we're talking about the useful life of these vessels, which will be through 2019 and 2020. And it is -- these vessels are well -- very well-maintained and can be traded beyond those dates.

Okay, got you. Okay, thanks so much, guys.

John Reardon, Western International.

Seems like the Company is doing well and is being run well, etc.

My question is regarding the A shares. It seems like the response to the A shares trading on a public exchange and being registered has always been, well, we are in registration and we are evaluating things. Well, that has been the response for quite some time. And I guess what I'm asking is what does it take to move the ball forward to actually have that take place and what is the evaluation?

Certainly, overall industry conditions are pretty well. The Company's numbers you just produced are pretty good. It seems to me that there shouldn't be too much problem floating a public offering of sorts and giving us A shareholders some degree of liquidity. That is my question.

This is James Small, the General Counsel. Your question raises a couple of points that I would like to address.

First, whether or not we list the A shares is a determination that we are attempting to address and are considering. As you know, the A shares were all issued in private transactions initially. So there are certain restrictions on our ability to create a public trading market with the shares that were issued at emergence from bankruptcy.

To your second question as to whether or not the Company should do a capital raising to facilitate the listing of A shares, while I would defer to Rick and Ian on that, I would note that the requirement to raise capital is itself a Company consideration that we do consider from time to time but we have no particular -- I can't really comment on it, frankly, because we are in registration in terms of timing.

John, I would add that as I said in my earlier remarks, it is absolutely a priority of the Company to get those A shares trading.

Okay, thank you.

Oliver [Bute] , [Refroat].

Good quarter, guys. The questions relate to the bonds. How much cash do you -- and you may have answered this question, but it was a little unclear to me. How much cash do you currently have at the issuer where the bonds reside?

The total cash we have is $654 million. And as Rick said earlier, we don't break it out between the businesses.

Okay. And what is the specific mechanism you'll use to transfer cash? I understand that there are allowances under the credit agreements to move cash to the holding company, but what are the specific mechanisms for moving cash? Will it be dividends? Will it be notes to the parent company?

How do you expect to transfer cash in the future, without commenting specifically on when you will do it or how much you will move up?

The credit facilities allow for dividends pursuant to the outline in the credit agreement for dividends to be paid. So our current approach would be to execute against the dividend baskets that we would have under those agreements.

Okay. And then the rationale for the amount of bonds that you acquired in the secondary market, like which particular maturity that you repurchased, could you just walk us through the way you reached those conclusions?

[John], it was really based on what was available in the market. We had -- as I mentioned earlier, we have bought back $62 million of the 2018s and $39 million of the 2021s and 2024s.

But -- so did -- just to help me go through this, did you have a party in the market looking for these bonds for you or did people come in to the Company and offer these particular bonds?

We were opportunistic with people that approached us.

Understood, thank you.

Steve Sylvester, Alcentra.

I'm just wondering if you could provide a little bit more color on the softness in the Jones Act trade that you mentioned and, specifically, in terms of your fleet that is coming up for renewal in early 2016 and 2017. When do you start working on those contracts? And how do -- in terms of contract rate, what do you expect in terms of discount to current rate generally?

So, Steve, there have been quite a few questions on the call on ATB, I would just like to comment a little bit on our domestic business.

We have 24 vessels in our domestic business, 22 Jones Acts, and we are still the number one player in that sector with a very large and young tanker fleet. And as we discussed from an accounting perspective, we decided to adjust the useful life of six of our ATBs.

In 2016, 81% of our Jones Act days or revenue days are fixed out. And we said there is a fair amount going out beyond that. So, Henry and his team in Tampa talk with our customers all the time. And it's an ongoing process as I said in my remarks. We fixed one of our tankers out on a three-year time charter during this quarter and we will continue to do that.

Okay, so specifically when the market softens, it softens more drastically in the ATB space and more specifically in older vessels, correct?

Not specific ATBs, but as markets soften, it provides customers with a somewhat greater advantage which is why we believe they will tend to take this wait-and-see approach. And as new builds deliver into that sector which have already started or will continue over the next two years, we anticipate that the older vessels in the fleet will come under the most pressure, of which a number are ours.

Thank you.

(Operator Instructions) I am showing no further questions. I would like to turn the program over to Ian Blackley for any additional remarks.

So, I just want to thank everyone for joining and we look forward to speaking to you in a few months. Thank you all.

Ladies and gentlemen, thank you very much for your participation. This does conclude the program. You may now disconnect.